The latest projections from the US Federal Reserve suggest that the central bank expects US interest rates to stay close to zero for at least three years. But the markets didn’t like it.
Market shed tears as Fed says rates to stay close to zero for at least three years
It takes a lot sometimes. Yesterday the US Federal Reserve made what was perhaps the most expansionary announcement ever. Its projections suggest it expects interest rates to stay close to zero per cent until at least 2023. Note that, ‘at least’. I am not sure we have ever seen the likes before. On such announcements, you would expect markets to go out and buy, as if all their Christmases had come at once. Instead they were disappointed; they had expected more.
Can you imagine, in 2007, if someone had predicted interest rates falling to near zero per cent within a year, and that with the exception of a brief interlude when they might rise modestly, would stay there for at least 16 years! You might have politely enquired after their health, suggested they take a holiday or see a doctor.
Can you imagine a scenario in 2007, in which interest rates would hover around zero per cent until 2020, but that despite this, in August 2020, UK inflation would be 0.2 per cent.
You see, by any conventional measure, the last 12 years or so have been weird. They should have turned conventional thinking on its head, but people are still applying conventional thinking. How many people think that an inevitable consequence of monetary policy and QE will be runaway inflation? How many say that as a result we should buy gold? But the economy is weird and they apply normal thinking. They are like someone turning up at a fancy dress party in a business suit.
The ladies and gentlemen at the Fed have two interesting characteristics. Firstly, they don’t like crystal balls. Secondly, they like to talk in code.
If you ever meet a member of the Fed’s rate setting committee, the FOMC, enquire after their health. Now I must admit, I tend to talk in code when asked that question. If I say “okay, thanks,” it means I feel awful. If I say “very well thank you,” it means I feel average. If I feel slightly better than normal, I might follow-up the “very well thank you?” with an explanation to detail why I feel ‘very well.’ But with a member of the Fed, I suspect it would be more subtle than that. I suspect that if they replied “my mood is sustainably better than normal,” that means they are happy. If instead they said “I am on track to be better than normal,” then that means they are feeling glum.
At least that is how I interpret the analysis of the Fed’s latest statement. It said that rates won’t be increased “until labour market conditions have reached levels consistent with the [FOMC's] assessments of maximum employment and inflation has risen to two per cent and is on track to moderately exceed two per cent for some time.”
The markets had hoped it would have instead said that rates won’t rise until its target was “sustainably achieved.” And because the Fed said “on track,” instead of “sustainably achieved,” the S&P 500 lost value. I guess it’s a little akin to buying one of your kids the latest state of the art games console, only for them to have a tantrum because the wrapping paper was the wrong colour.
But as I say, the Fed doesn’t like looking at a crystal ball. Some bloke called Mark Twain, not sure who he is, I think he may be an economist at the bank of Huckleberry Finn, is supposed to have said that “making predictions is difficult, especially about the future.” Although there is no evidence he actually did say this, I am sticking with Twain as my source as it sounds much better than “someone once said.” But be all that as it may, the Fed doesn’t like making predictions about next Tuesday, let alone 2023.
And by the way, analysts are now saying that the date when interest rates do go up is likely to be even further away than 2023.
And yet, inflation remains about as scary as a puppy in a playful mood. In August, UK inflation fell to 0.2 per cent. I know what you are thinking, the data was distorted by Rishi’s eat out scheme. Well it was, but only a little bit. “The plunge in inflation... was broad based,” said, Thomas Pugh, UK economist at Capital Economics. He also predicted a modest rise in inflation early next year, and reckons two per cent is possible in 12 months time when the effect of Rishi’s deal works its way out of the figures. However, he also reckons “that a sustained rise to two per cent is unlikely within the next few years.”
Talking of puppies
Talking of playful puppies, there are certain products (if you can call a puppy a product), that have been subject to high inflation. My mongrel, otherwise known as a labradoodle, (and also Bonnie) set me back £950, three years ago — which I thought was expensive. Now they cost getting on for £3,000. We have also seen extreme inflation in gym memberships and bicycles.
The reason why the Fed and Bank of England can merrily keep rates at zero, indulge in QE, and say happy words like “sustainable,” is because we are seeing a chronic shortage of demand. Post-covid, unemployment will be high, median real wages may fall, demand will stay low.
If the UK stamps tariffs on food imports from the EU, we will see a one-off increase in food prices, but long-run such a move will suck demand out of the economy and will be deflationary.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees